With big changes in store for the Free Application for Federal Student Aid (FAFSA), families with college-bound children should revisit their savings strategy today. Some may find that they’ll come out ahead when the new rules take effect. But many others, including divorced parents and those with children who are close in age, could see their out-of-pocket tuition costs climb considerably.


The FAFSA is completed each year by college students seeking federal financial aid, including grants, work study, and student loans. Most states and colleges also use the financial inputs provided on the FAFSA to help determine eligibility for other forms of financial aid, including need-based grants and merit-based scholarships.

In its current iteration, however, the FAFSA form is widely considered to be cumbersome, which advocates for equity and access believe deters some students (particularly those from underserved communities) from pursuing a college degree. In response, the Consolidated Appropriations Act of 2021 included provisions to simplify the FAFSA and the federal-aid delivery system. It also implemented some significant new changes that will affect how much millions of students will pay toward tuition, fees, and room and board.

Key changes to the financial aid eligibility formula, which take effect beginning with the 2024-25 academic year, include:

  • Fewer questions about untaxed income.
  • The “Expected Family Contribution (EFC)” formula will become the “Student Aid Index (SAI).”
  • The parent who provides the most financial support will have to complete the FAFSA.
  • The discount for families with more than one child in college disappears. 

As noted, families will begin using the new, simplified FAFSA form beginning with the 2024-2025 academic year, but because the calculation is based in part on household income two years prior, 2022 will become the base income year for the first application cycle using the new formula.

“That’s why some of the strategies to maximize financial aid should be implemented now,” said Chany. “The game has already started.”

Rory Sullivan, a financial professional with MassMutual Greater Philadelphia who specializes in college planning, said he’s working closely with clients who plan to help pay for their children’s education, projecting future expenses and exploring alternative savings tools.

“We don’t have a crystal ball, but we always advise younger parents to take a look at where they are today and look at the financial aid rules, so they understand how aid eligibility is determined,” he said. “The whole goal is to pay for college with cost-efficient dollars — to spend less so they have more for retirement.”

Fewer questions about untaxed income

For families that have already submitted a FAFSA, the first thing they may notice when the new form goes live is that it’s shorter. The number of questions was reduced from 106 to 36, although few applicants using the current form have to complete all 106 questions.

On the simplified FAFSA, many questions regarding untaxed income (that does not appear on a federal tax return) have been eliminated for both students and parents. For example, questions regarding payroll contributions to tax-deferred retirement accounts, such as a 401(k) or 403(b), will no longer be included. But the untaxed portion of any IRA, pension, or annuity distribution will still be considered in the financial aid formula. So, too, will contributions to a traditional IRA, Keough, SEP IRA, SIMPLE IRA and other retirement plans claimed as an adjustment to income on the applicant’s tax return, said Chany.

There are also fewer questions related to sources of cash support.

Most significant, child support will now be considered an asset, versus untaxed income, which is treated more favorably in the financial aid formula.

Workmen’s compensation and veterans’ noneducation benefits will not be reported.

And students will no longer be required to report any financial support they receive from friends and extended family members on the new FAFSA, including distributions from grandparent-owned 529 college savings plans.

That means generous grandparents will now be able to help save for their grandchildren’s college education without running the risk of negatively affecting their grandchildren’s financial aid eligibility. At present, up to 50 percent of annual student income received from grandparents (or friends and other relatives) is deemed eligible for college use, which can hurt students’ chances for need-based awards.

Grandparents should be aware, however, that distributions from their 529s could still potentially affect their grandchildren’s financial aid because some colleges may still consider it to be a resource. That could reduce the award package by an amount equivalent to the distribution.

Simplified may not mean easier

Despite all efforts to simplify the FAFSA, Chany predicts that the new form may not make the aid application process any easier for families in the long run. He said colleges may respond with new document requirements that capture the financial information no longer being asked.

“Don’t jump for joy just yet,” he said. “Any college that gives out their own institutional aid isn’t going to be happy about the elimination of many untaxed-income and other questions. They’ll start requiring other forms.”

Many selective colleges, typically private schools, already ask students to submit the CSS Profile financial aid application in addition to the FAFSA, he said, which requests far greater detail on household income and assets. The College Board, said Chany, which administers the SAT, is already working on a second, more streamlined version of the CSS Profile form that some schools that previously only used the FAFSA may choose to use. And some may use the full, more robust CSS Profile.

“The process of securing student financial aid is going to be more difficult, not easier,” said Chany. “There are going to be winners and losers and those who don’t plan in advance are more likely to be losers because they won’t understand how these changes will affect aid eligibility.”

Goodbye EFC, hello SAI

The FAFSA creates an eligibility number, called the Expected Family Contribution (EFC), to determine a student’s demonstrated financial need. The EFC represents the dollar figure that the government believes a family can afford to pay for college.

But most schools do not meet 100 percent of a student’s financial need. Thus, families often pay far more for tuition, fees, and room and board than their EFC number would suggest, creating confusion and angst. Indeed, need-based awards differ greatly depending on the college’s initial sticker price, their aid budget, and whether it is a public or private institution.

To eliminate confusion about the EFC, the U.S. Department of Education has renamed its calculation the Student Aid Index (SAI).

Apart from the new name, the federal aid formula will permit a “negative SAI,” which will allow states and institutions to more easily identify applicants with the most need who might qualify for institutional and state aid.

Custodial parents

Divorced or separated parents may find that their financial aid eligibility gets reduced when the new FAFSA kicks in.

Today, only the financial information of the custodial parent (usually the parent with whom the child resides the most) is reported on the FAFSA. That parent may or may not have legal custody and they need not be the parent who claims the student as a dependent on their income tax returns.

With the new FAFSA, however, the parent who provides the “most financial support” will be required to complete the application, regardless of where their child resides. The final policy guidelines have not yet been defined, but some believe the support test may well be determined by the parent that claims the child on their tax return.

“That’s an issue for parents to become aware of sooner rather than later, since the 2022 tax returns completed in 2023 could impact who must complete the FAFSA,” said Chany.

Multi-student discount

Families with children who are close in age may also get stung by the new changes to the FAFSA rules. Some may find that their out-of-pocket costs will double, or worse.

Why? The simplified FAFSA will still request information on the number of children they have in college that year, but the federal aid formula will no longer automatically take into account multiple children when determining what the family can afford to pay. (Learn more: FAFSA changes could double some family college costs: Are you ready?)

Currently, the parent contribution calculated in the federal aid formula is divided by the number of dependent children they have in college simultaneously. Thus, if the parent contribution was determined to be $40,000 per year, it would be reduced to $20,000 per child if they have two children in college, and $13,333 per child if they have three children in college at the same time, etc. That substantially increases each child’s eligibility for need-based financial aid.

Because the multiple-children discount was so valuable, college planning professionals once suggested that families with children who are two years apart in school consider having their oldest take a gap year, so they could divide their eligibility for aid for three years when their children would be in college together. But that strategy may no longer work.

“That discount on the FAFSA will disappear and it could be a huge loss for a lot of families,” said Sullivan.

At their discretion, some colleges may still decide to offer the multiple children discount when awarding their own financial aid dollars.

Ways to save

The new FAFSA could force many families to revisit their college funding strategy.

Sullivan said parents all too often pump money into a 529 college savings plan from the day their child is born without considering alternatives.

“A 529 plan can be great, but it’s just a tool,” said Sullivan. “It’s not a strategy.”

Indeed, saving exclusively into a 529 college savings plan could potentially hurt the student’s eligibility for need-based financial aid because 529s owned by either a dependent student or a parent are considered to be a parental asset, which may reduce their financial aid package by up to 5.6 percent of the asset’s value. In most cases, the overall impact to financial aid is minimal.

The bigger issue is if your child opts not to attend college, or you over save because your child attends a less expensive school than projected. Any 529 earnings not used for qualified education expenses are subject to ordinary income tax, plus a 10 percent penalty. (Related: Alternatives for 529 college savings)

For that reason, Sullivan said a tax-favored Roth IRA, annuity, or cash value life insurance policymight be appropriate for some families, especially younger parents who don’t yet know what path their child will pursue. In some cases, a combination of tools that includes a 529 college savings plan might be optimal.

Roth IRAs, annuities, and cash value life insurance policies can all be used penalty free to pay for qualified education expenses and those dollars are available for your own retirement needs if you do not need the money for college. Keep in mind that while these accounts are not considered an assessable asset on the EFC (and future SAI) formula for determining financial aid, distributions in any year that is used to determine eligibility for financial aid will be counted as untaxed income. Certain assets that are not reported on the FAFSA, however, may be reportable on the CSS Profile application. A financial aid expert can provide guidance on how the assets you own may affect your eligibility for financial aid. (Calculator: How much do I need to save for college?)

“We don’t know what will happen in the future, but if we save into investment vehicles that can be used for both college and retirement, we have more options,” said Sullivan.

He notes that parents should only save for college in a Roth IRA if they are already saving enough for their own retirement. Always prioritize your retirement savings over helping your child pay for college. They can get a student loan, but there are no loans for retirement expenses.

“We always want to begin with the end in mind,” said Sullivan. “Start with your retirement plan and then determine how much you can help fund your child’s college education. Otherwise, you won’t be happy at age 67 when you want to retire but can’t.”

As for using life insurance to fund college expenses, Sullivan said families could potentially purchase a 10-pay or 20-pay cash value life insurance policy, in which premiums are fully paid in 10 or 20 years. Their child could then take out federal loans (that do not accrue interest) while in school, giving the policyowner four additional years to grow their cash value on a tax-deferred basis. Then, when their child graduates, the policyowner could help pay off their child’s student loans using the cash value they have accrued.

Take note that the primary function of life insurance is to provide a death benefit to your loved ones, giving them resources to help maintain their lifestyle if you (the policyowner) should die prematurely. Access to cash value through borrowing or partial surrenders will reduce the policy’s cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.

Roth IRAs, annuities, and permanent life insurance come with their own rules, risks, and potential benefits. They also offer different investment options.

With new FAFSA rules on the horizon, parents saving for their children’s college education should consider consulting a professional to assess the implications to their future costs and discuss strategies that may help them meet their savings goals.

By Shelly Gigante
Shelly Gigante specializes in personal finance issues. Her work has appeared in a variety of publications and news websites.
Posted on Apr 25, 2022